1. MARKET FOR FACTORS OF PRODUCTION
Lecturer: Jack Wu

2. FACTOR OF PRODUCTION Factors of production Factor markets
Inputs used to produce goods and services
Labor, land, and capital
Factor markets
The demand for a factor of production is a derived demand
From firm’s decision to supply a good in another market

3. DEMAND FOR LABOR Labor market Labor demand
Governed by supply and demand
Labor demand
Derived demand
Labor services = inputs into the production of other goods

4. The versatility of supply and demand
(a) The market for apples
(b) The market for apple pickers
Price of
apples
Wage of
apple
pickers
Supply
Supply
Demand
Demand P W Q L
Quantity
of apples
Quantity of
apple pickers

5. DEMAND FOR LABOR Assumptions Firm is competitive in both markets
For goods and for labor
Price taker
Pay the market wage
Get the market price for goods
Decide
Quantity of goods to sell
Quantity of labor to hire
Firm is profit-maximizing

6. DEMAND FOR LABOR Production function Marginal product of labor (MPL)
Relationship between the quantity of inputs used to make a good and the quantity of output of that good
Marginal product of labor (MPL)
Increase in the amount of output from an additional unit of labor
Diminishing marginal product
The marginal product of an input declines as the quantity of the input increases

7. VALUE OF THE MARGINAL PRODUCT OF LABOR (VMPL)
Marginal product of labor times the price of the output
Marginal revenue product
Additional revenue from hiring one additional unit of labor
Diminishes as the number of workers rises

8. How a competitive firm decides how much labor to hire
Output Q
Marginal product
of labor
MPL=ΔQ/ΔL
Value of the
marginal product
VMPL=P ˣ MPL
Wage W
Marginal profit
ΔProfit=VMPL-W
0 workers 1 2 3 4 5
0 bushels
100
180
240
280
300
100 bushels 80 60 40 20
$1,000
800
600
400
200
$500
500
300
100
-100
-300

9. Profit Maximizing Quantity of Labor
Value
of the
marginal
product
Value of marginal product
(demand curve for labor)
Market
wage
Profit-maximizing quantity
Quantity of
apple pickers

10. WHAT IS LABOR DEMAND CURVE?
Competitive, profit-maximizing firm
Hires workers up to the point where
Value of the marginal product of labor = wage
The value-of-marginal-product curve is the labor- demand curve
For a competitive, profit-maximizing firm
Labor-demand curve
Reflects the value of marginal product of labor

11. SHIFTING LABOR DEMAND CURVE
What causes the labor-demand curve to shift?
The output price
Demand for labor: VMPL = MPL ˣ P of output
Technological change
Technological advance
Can raise MPL: increase demand for labor
Labor-saving technology
Can reduce MPL: decrease demand for labor
Supply of other factors
Affect marginal product of other factor

12. LABOR SUPPLY The trade-off between work and leisure Labor-supply curve
Reflects how workers’ decisions about the labor-leisure trade-off
Respond to a change in opportunity cost of leisure
Upward sloping curve or backward sloping curve?
What causes the labor-supply curve to shift?
Changes in tastes
Changes in alternative opportunities
Immigration

13. EQUILIBRIUM Wages in competitive labor markets
Adjusts to balance the supply & demand for labor
Equals the value of the marginal product of labor
Changes in supply or demand for labor
Change the equilibrium wage
Change the value of the marginal product by the same amount

14. Equilibrium in a labor market
Wage
(price of
labor)
Supply
Demand
Equilibrium
wage, W
Equilibrium
employment, L
Quantity of
labor

15. CHANGE IN EQUILIBRIUM Increase in supply Decrease in wage
Lower marginal product of labor
Lower value of marginal product of labor
Higher employment

16. An increase in labor supply
Wage
(price of
labor)
1. An increase in
labor supply . . .
Supply, S1
Demand S2 W1 L1
reduces
the wage . . . W2 L2
Quantity of labor
and raises employment.

17. CHANGE IN EQUILIBRIUM Increase in demand Higher wage Higher employment
No change in marginal product of labor
Higher value of marginal product of labor
Higher employment

18. An increase in labor demand
Wage
(price of
labor)
Supply
Demand, D1 D2
1. An increase in
labor demand . . . W2 L2
increases
the wage . . . W1 L1
Quantity of labor
and increases employment.

19. OTHER FACTORS OF PRODUCTION
Capital
Equipment and structures used to produce goods and services
Equilibrium in the markets for land & capital
Purchase price
Price a person pays to own that factor of production indefinitely
Rental price
Price a person pays to use that factor for a limited period of time

20. RENTAL PRICE Wage – rental price of labor
Rental price of land & Rental price of capital
Determined by supply and demand
Demand – derived demand
Reflects marginal productivity of the factor
Each factor’s rental price = value of marginal product for the factor

21. The markets for land and capital
(a) The market for land
(b) The market for capital
Rental
price of
land
Rental
price of
capital
Supply
Supply
Demand
Demand P P Q Q
Quantity
of land
Quantity of
capital

22. PURCHASE PRICE Equilibrium purchase price
Of a piece of land or capital depends on
Current value of the marginal product
Value of the marginal product expected to prevail in the future